Fintech Wave's beginner's guide to Neobanks💳
Neobanking expert after reading this article 👉4/10
We are welcoming 38 new members of the Fintech Wave community👏 This week, instead of our regular newsletter, we decided to send out a neobanks report. If you are new to fintech you will learn what neobanks are, how they operate, make money, and a current neobank market overview - biggest players, valuations, etc.
It would mean a lot to us if you could support us on our journey by sharing this article on your social media…that is if you like it!
Let’s deep dive into it👇
What is a neobank
Neobank, also often called a "challenger bank" is a bank without standard infrastructure such as ATMs, brick-and-mortar branches, etc. In most cases, neobank product offerings are more straightforward than a regular bank. For instance, most neobanks don't offer loans, but their debit/credit card offering is much broader than in a standard bank. A great example is the "Single-use virtual "card provided by almost any neobank. Let's say that you are buying from a webshop for the first time and you are not sure if the webshop is trustworthy. You can generate a valid card for just one purchase, so you will be protected even if your card data gets stolen.
Try to do that with your standard bank! 😎
P.S. Don’t know about you, but every time I go to my “standard” bank I have to sign some paperwork.
Neobank market in a glimpse
It is hard to know the exact number of neobanks worldwide, but according to the relevant data, there are around 270 neobanks worldwide. Even though the USA market is the most fruitful one regarding VC funding amounts and VC funds in general, Europe has the most neobanks HQ's (87), followed by the USA (70). The big surprise is South/Latin America with 55 neobank HQs. Out of all markets, this is the most buoyant one.
Comparing neobanks by the number of users can be deceiving because neobanks that originate from a large country where competition is not intense are expected to have a lot of users. However, WeBank's 270 million customers are impressive. NuBank is active only in three markets (Brazil, Mexico, and Columbia), but it managed to gather 65 million customers, while Revolut's 20 million customers are spread across 50 countries.
Public vs Private valuations
This is a grey area because private valuations are based on VC funding rounds. For instance, before NuBank (Brazil) went public, its private valuation was over 40$ billion, while on the stock market, NuBank market cap is 17$ billion. So you can say that the market values NuBank 2,5 times less than private/VC investors.
Even though Kotak Mahindra has the largest market cap, Kotak Mahindra is not just a neobank, it's a group of different divisions, and a similar story is for Kakao Bank. If we are looking just at the neobanking business, NuBank is the leading neobank in the world.
Public neobanks
Africa/Middle East is the only region that doesn't have a public neobank. However, the African/Middle East market is exciting regarding banking and finance, which we will cover in the future. Africa accounts for 70% of the world's $1 trillion mobile money value. The value of Africa's mobile money transactions increased 39% to $701.4 billion in 2021 from $495 billion in 2020. They still don't have a public neobank primarily due to insufficient overall financial markets infrastructure.
If we look at the countries alone, USA and Brazil both have 4 public neobanks. Russia and Australia follow with 2 each. The United Kingdom/England is a big "negative "surprise with only 1 public neobank. The United Kingdom/England has 22 neobanks HQs on their territory, the most in Europe. But, it is expected that Revolut, Atomic Bank, Monzo bank will become public soon, thus changing the number.
Public neobanks market caps
Neobanks revenue streams
Because neobanks are disruptors in an ancient industry, their revenue generation tactic is slightly different. Like any "new kid on the block", they are trying to sign as many customers as possible. To do that, neobanks are willing to dismantle almost all standard banking industry revenue generation streams. In most cases, they don't charge monthly fees for having the account, overdraft fees are non-existent/much lower than in a standard bank, and if they charge a fee, it's lower than a traditional bank would charge.
How is this possible?
Neobanks don't have the standard banking infrastructure, so their associated infrastructure costs are lower, and many of them have substantial VC money that they use for growth. They are not profitable, but they have enough cash to cover the loss…at least until the next VC round! 👹
There are 5 main revenue streams for neobanks:
1. Interchange fees
Interchange fees are the transaction costs merchants pay each time a customer uses a card. More simply said, each time you pay anything with your neobank card, for neobank that is revenue. This is why neobanks are urging their users to use their cards as a primary payment option, and that is why neobanks are so open to innovation in the card segment, such as "Single-use "cards.
2. ATM withdrawal fees
Since neobanks don't have their ATMs, they charge a fee if you want to withdraw cash. Many neobanks offer "free "withdrawals up to a certain amount, but that only means they are paying fees instead of you up to a certain amount. The amount varies depending on your account type; free of premium. Premium accounts have a higher amount of "no fee" withdrawal limit.
3. Product fees
Some neobanks went outside of the standard banking practices, and through their application, you can invest in stocks/crypto market, buy car/home/life insurances, and many more. This is somewhat unique to neobanks when comparing them to regular banks. Regular banks also can offer such services, but not in a way neobanks can; through one application.
4. Interest income
This is a standard banking industry revenue, and neobanks offering loans have this type of income. This also includes interest income from credit cards.
5. Premium accounts
With a regular bank, it's mandatory to pay a monthly fee for the account. With neobanks that is not the case, but they do have different types of premium (paying) accounts. For instance, Revolut (one of the largest European neobanks) in their premium accounts offers perks such as:
Reduced fees on cryptocurrency trading
No currency fee exchange (super helpful if you travel a lot)
Travel Insurance
Card personalization
Cashback
Under 18 accounts (somewhat of a family account)
Increased limit for no-fee ATM withdrawal
To conclude, for a neobank that doesn't offer loans, the primary source of income is Interchange fees, and for a neobank that provides loans, Interest income is most likely the primary source of income.
Behind the fancy application
There is a good reason why the banking industry is such a closely regulated industry. After all, we are talking about money here. But, if the banking industry is so regulated, how can there be so many new neobanks/fintechs/investment applications, etc?
The answer lies in one term; banking license.
There are three types of banking licenses the company can acquire if they want to become a neobank/fintech:
1. Full Banking License
*It’s worth mentioning that only a handful of neobanks own this license.
This is your standard banking license, a license you would expect from a bank. This banking license allows financial institutions to accept customer deposits and issue loans using those customer funds. It also provides the broadest scope of services, but the downside is that this license is the most heavily regulated.
There are two sets of authorities that can issue such a license; national authority or supernational authority.
A national authority is, in most cases, a central bank that covers a specific country. So if you want to open a bank in, let us say Japan, you would need approval from their central bank, and the banking license would be valid only for Japan.
Supernational authority such as the European Central Bank (ECB) in Europe or the Federal Reserve (Fed) in the United States gives more flexibility. For example, once you get an ECB banking license, you can operate in the whole EU.
The main "problem "with the "Full Banking License "is that the application process is lengthy and can take up to 15 months, depending on the jurisdiction. Not to mention the cost of the whole process😱
2. Fintech License or "Payment "License
Jurisdictions across the globe realized that the banking industry was set for a change, so they embraced innovation through new types of financial services licenses. These are typically light versions of banking licenses designed to accommodate digital business models, thus allowing these institutions to offer financial services. For our European readers, PSD1 and PSD 2 regulations should "ring the bell".
As part of the banking transformation, two types of sub-licenses emerged:
Electronic Money Institution License
Electronic Money License (EMI) supports digital payment services, including creating IBANs, issuing electronic money (BIN Sponsorship - Credit Card), and management thereof, where the end-user can maintain funds in the account.
This license provides customers with the same banking experience for everyday payments as a full banking license.
Of course, there are limitations to the EMI license:
Neobank, under the EMI license, can't offer loans to customers, which is a vital revenue stream.
An EMI license holder cannot take full custody of client funds and must use a partner bank (a credit institution) instead.
An EMI license holder may face limitations on the maximum amount customers can hold in their e-wallets, as well as limits on certain transactions
The Payment Institution License
A Payment Institution License (PI) is broader than an EMI license. It supports various payment services enabling transactions to be carried out by card, mobile app, transfer, or direct debit. It also supports cash withdrawals, account deposits, foreign exchange transactions, and data processing (Open Banking players - Account Information Service Provider and Payment Initiation Service Provider).
Under a PI license, offering long-term loans to the client is still not possible, but it is possible to provide short-term loans. However, only loans repayable within a maximum of 12 months are allowed and only to customers with an account with a payment institution. Within this framework, the payment institution manages the monthly direct debit transactions for the traditional bank that finances the credit.
If you compare that to the standard bank, you don't have to have an account in that specific bank to get a loan from them.
Under PI license, the financial institution cannot take custody of the client's funds which must be deposited with a credit institution, where the funds are guaranteed up to a certain amount. That amount in Europe is usually 100,000€.
3. The Partnership model or The Payment service provider agent model
The most significant advantage of this license type is that it allows startups to bypass the lengthy and complex license application process. Startups, or other organizations, do not necessarily need to hold these licenses on their own; they have the option of operating under the auspices of a licensed financial institution. Credit institutions, payment institutions, and electronic money institutions, approved by a regulatory body, may use agents they have commissioned to provide payment services under their responsibility.
Conclusion
First of all, congratulations on reading until the end! 🚀 This was just a small glimpse into the neobanking world, and we prepared much more about neobanks for our readers. We hope that after reading this newsletter edition, you will have enough knowledge about neobanks to impress your friends and colleagues at work😅
To give you even more material, we will write deep dives into specific markets (South/Latin America, Africa etc), analyze neobanking stocks and much more in the following weeks. If you like what we are doing, please share our work with your connections on social media.